Revenue Recognition Cases Véronique Weets

Transcription

1 Revenue Recognition Véronique Weets

2 CONTENTS IAS 18 Revenue... 3 Measurement... 3 IAS 11 Construction contracts... 4 Scope of IAS Contract revenue and contract costs... 5 Stage of completion... 6 Recognition of revenue and cost... 7 Contract losses... 8 Recognition in the statement of Financial position... 9 Specific issues revenue recognition Reporting revenue gross versus net Multiple element transactions Customer loyalty programmes (IFRIC 13) IFRIC 18 Transfers of assets from customers Transfer of an electricity substation in exchange for connection to a price regulated network. 14 Who controls the asset? Transfer of assets in an outsourcing agreement Combining and segmenting construction contracts IFRIC 15 Agreements for the construction of real estate Group discussion Scope of IAS 11 or IAS Instituut van de Bedrijfsrevisoren 2

3 IAS 18 REVENUE MEASUREMENT 1. An enterprise sells a piece of heavy equipment for 10,000 under a financing agreement, which has no stated interest rate. The sale takes place on 31/12/X0. Annual installments of 2,000 are due each year for five years from the date of purchase. Another buyer paying cash would be charged 10,000 for the equipment, this it is a zero per cent financing arrangement. Based on the customer s credit rating, the seller believes that the buyer would be able to obtain financing with an interest rate of 10%. Additional information: Discount factors for a 10% discount rate are as follows: Year Present value discount 10% Compound discount 10% What is the amount of revenue that should be recognized on initial sale and in subsequent periods in relation to this transaction? 2. An enterprise sells a piece of heavy equipment for 10,000 under a financing agreement, which has no stated interest rate. The sale takes place on 31 December of Year 0. Annual installments of 2,000 are due each year for five years from the date of purchase. If the buyer had paid cash for the equipment, the sales price would have been 8,000. What is the amount of revenue that should be recognized on initial sale and in subsequent periods in relation to this transaction? Instituut van de Bedrijfsrevisoren 3

4 IAS 11 CONSTRUCTION CONTRACTS SCOPE OF IAS 11 Determine whether IAS 11 should be applied for the following contracts Contract In the scope of IAS 11 Out of the scope of IAS 11 A construction contract with a duration of less than one year A contract to construct large machines that are individually built to customer order and unique specifications A service transaction A software development contract Instituut van de Bedrijfsrevisoren 4

5 CONTRACT REVENUE AND CONTRACT COSTS 1. Olegna is a software design company that develops software specifically suited for a particular customer. In order to secure the contract with Enile, Olegna incurs costs related to determining what steps and internal costs will need to be incurred in order to bid on a project for Enile. Such costs may include labor costs, general administration costs, research and development costs, etc. Many of these costs are incurred prior to securing the contract (herein referred to as precontract costs) (Deloitte, i GAAP, pg. 1601) How should Z account for pre contract costs? 2. A company has a construction contract for land reclamation. This involves clearing old collieries. As a by product the company is entitled to sell off any coal that it recovers. On this site there are coal deposits, which the company has sold to a third party, although it has not yet recovered the coal (PWC, 2007,pg 20047). Can the company take the cash received from the third party to income as it considers there will only minimal costs in recovering the coal? Instituut van de Bedrijfsrevisoren 5

6 STAGE OF COMPLETION 1. Tanner Ltd year ended 31 December 20X5 (ACCA) Costs to date 1,500 Future expected costs 1,000 Expected sales value 3,000 Revenue taken in earlier years income statement 1,200 Cost taken in earlier years income statement 950 Calculate the figures to be taken to the income statement in respect of revenue and costs year ended 31 December 20X5 on a cost basis 2. Olegna undertakes a three year contract. At the end of year 1, when the outcome of the contract can be estimated reliably, management estimates that the total revenue on the contract will be CU1,000 and that total costs will be CU900, of which CU300 have been incurred to date. Included in the CU300 are purchased materials to be used in year 2 of CU50. Revenue 1,000 Costs incurred to date (300) Estimated costs to complete (600) Estimated gross profit 100 a. Calculate the percentage of completion of the contract at the end of year 1. b. In year 2, costs of CU300 are incurred. Management estimates that costs of CU350 will be incurred in year 3. Calculate the percentage of completion. 3. Olegna incurred CU3 million of pre contract costs during December 200X, which were directly attributable to the anticipated contract with Enile and which T believed would be recoverable under that contract. However, due to the uncertainty of the outcome, Olegna expensed the costs when they were incurred in 200X. The contract was ultimately signed in 200Y for a price of CU18 million. Olegna s remaining estimated costs to complete the contract were CU6 million. Should Olegna include the pre contract costs for the calculation of the stage of completion on a proportionate cost basis? Instituut van de Bedrijfsrevisoren 6

7 RECOGNITION OF REVENUE AND COST 1. Mapperley plc. prepares financial statements to 31 December each year. The company began work on a construction contract on 21 June 20X6 and completed the contract work on 13 August The contract price was initially set at CU,500 and this figure did not change throughout the duration of the contract. Cost information is as follows: 31/12/X6 (CU) 31/12/X7 (CU) 31/12/X8 (CU) Expected total costs Total costs incurred to date Costs relating to future activity 10 8 The costs incurred to date of CU250 at 31 December 20X6 and CU440 at 31 December 20X7 included CU 10 and CU 8 respectively for materials to be used in the following year s contract work. The company determines the stage of completion of a contract by comparing the costs incurred to date with the estimated total contract costs. Compute the revenue and expenses which would be shown in relation to this contract in the company s income statement for each of the years to 31 December 20X6, 20X7 and 20X8 (Melvile, ex. 10.4, pg ). Instituut van de Bedrijfsrevisoren 7

8 CONTRACT LOSSES Aida NV signs a three year contract with Ramades SA. Management can estimate the outcome of the contract reliably at the end of year 1. At that moment estimated total contract revenue is CU 2,400 and total costs will be CU 2,000. CU 800 were incurred during year 1 (Cethys, 2008). a. Calculate the percentage of completion of the contract at the end of year 1, and the amounts of revenue and costs that will be included in the profit and loss statement. b. In year 2, costs of CU900 are incurred. Management estimates that the costs to complete the contract are CU 1,000. Calculate the amount of revenue and cost to include in the profit and loss statement. Instituut van de Bedrijfsrevisoren 8

9 RECOGNITION IN THE STATEMENT OF FINANCIAL POSITION Olegna has the following contracts as at 31 December 20X5: A B C CU000 CU000 CU000 Contract value Costs to date Estimated costs to complete Billings Date started during the 1 January 1 November 1 January year % completion 45% 3% 80% Prepare the extracts from the accounts of Olegna as at 31 December 20X5. Olegna s policy is not to recognize profits until contracts are 10% complete. Instituut van de Bedrijfsrevisoren 9

10 SPECIFIC ISSUES REVENUE RECOGNITION REPORTING REVENUE GROSS VERSUS NET 1. A travel agency makes an airplane reservation for a customer, collects 1,000 CU from the customer, delivers the ticket to the customer, remits 930 CU to the airline and retains 70 CU as commission. The travel agency acts purely as agent for the airline, assuming no responsibility for the flight (Alfredson et al.(2007), pg. 160, problem 4.5) Based on the definition and recognition criteria for income in the IASB Framework, do you think the travel agency had: a. 1,000 CU of revenue and 930 CU of expenses, leaving a 70 CU gross profit? b. 70 CU of commission revenue, with the 1,000 CU and the 930 CU not reflected in its income statement? 2. A manufacturer sells goods to Customer A, who has an unlimited right of return. If Customer A is not able to sell those goods to a third party, Customer A may return the goods to the manufacturer for a credit against future purchases from the manufacturer (but not for a cash refund) (Alfredson et al.(2007), pg. 160, problem 4.1) Under the IASB Framework, what should the manufacturer do? a. Recognize revenue when the goods are delivered to Customer A, with an appropriate allowance for estimated returns. b. Recognize revenue when Customer A resells the goods to a third party. 3. Company B operates in a country with a 17% VAT. The VAT is billed to the customer and remitted monthly to the government. Company B sells goods for 100 CU and bills the customer 117 CU Alfredson et al.(2007), pg. 161, problem 4.6). Under the IASB Framework, do you think Company B had: a. Revenue of 117 CU and VAT tax expense of 17 CU b. Revenue of 100 CU with no tax expense. Instituut van de Bedrijfsrevisoren 10

11 4. Company C operates an Internet site from which it sells the products of various manufacturers. Customers select products from the website and provide credit card and shipping information. The manufacturers establish the selling price. Company C receives the order and authorization from the credit card company and passes the order on directly to the relevant manufacturer, who ships the product directly to the customer. Company C does not take delivery of or title to the goods, and has no risk of loss or other responsibility for the product. The manufacturer is responsible for all product returns, defects and disputed credit card charges. Company C s fee is 20% of the sales price (Alfredson et al.(2007), pg.161, problem 4.7) Under the IASB Framework, how should Company C recognize revenue for this transaction? a. As gross of 100 CU b. As net of 20 CU Instituut van de Bedrijfsrevisoren 11

12 MULTIPLE ELEMENT TRANSACTIONS 1. A Telecom entity offers a package of services to its clients that combines both broadband and mobile telephone services. The main characteristics of the package are: The package is available free of charge to both new and existing customers who sign up to a mobile phone plan for 30 CU or more per month. This mobile phone plan includes free evening and weekend calls to landline. The broadband access is sold to other customers for 18 CU. There is no connection charge. Customers receive access to a free wireless modem which remains property of the Telecom entity and will have to be returned when the contract ends or is terminated. Nobody hires or buys such a modem without the broadband access plan. It has no value without the broadband access. a. Does this constitute a multiple element arrangement? b. Which elements should be separated for accounting purposes? c. How should the elements be accounted for? Instituut van de Bedrijfsrevisoren 12

13 CUSTOMER LOYALTY PROGRAMMES (IFRIC 13) How should the entity account for the following programmes? 1. A grocery retailer operates a customer loyalty programme. It grants programme members loyalty points whenever they spend a specified amount on groceries. Programme members can redeem the points for further groceries. The points have no expiry date. In one period, the entity grants 100 points. Management expects 80 of these points to be redeemed. Management estimates the fair value of each loyalty point to be one currency unit (CU1). In year 1, 40 points are redeemed in exchange for groceries. In the second year, management revises its expectations. It now expects 90 points to be redeemed altogether. During the second year, 41 points are redeemed, bringing the total number redeemed to = 81 points. In the third year, a further nine points are redeemed, taking the total number of points redeemed to = 90. Management continues to expect that only 90 points will ever be redeemed, i.e. that no more points will be redeemed after the third year. 2. A retailer of electrical goods participates in a customer loyalty programme operated by an airline. It grants programme members one point with each CU1 they spend on electrical goods. Programme members can redeem the points for travel with the airline, subject to availability. The retailer pays the airline CU0,009 for each point. In one period, the retailer sells electrical goods totaling CU1 million. It grants 1 million points. The retailer estimates that the fair value of a point is CU0,01. Instituut van de Bedrijfsrevisoren 13

14 IFRIC 18 TRANSFERS OF ASSETS FROM CUSTOMERS TRANSFER OF AN ELECTRICITY SUBSTATION IN EXCHANGE FOR CONNECTION TO A PRICE REGULATED NETWORK A real estate company is building a residential real estate development in an area that is not connected to the electricity network. In order to have access to the electricity network, the real estate company is required to construct an electricity substation that is then transferred to the utility company operating the electricity network. The transferred electricity substation becomes an asset of the utility company that it must maintain or replace at its cost. The utility company uses the transferred asset to connect each house of the residential real estate development to its electricity network. By regulation, the utility company has an obligation to provide on going access to the electricity network to all connected customers at the same price, regardless of whether the customers transferred an asset. Customers can choose to purchase their electricity from suppliers other than the utility company but must use the utility s network to receive it. Alternatively, the utility company could have constructed the substation and received a transfer of cash from the developer that had to be used only for the construction of the substation. The substation remains however an asset of the utility company. How should the utility company recognize the transfer of the substation? WHO CONTROLS THE ASSET? a. A house builder constructs a house on a brownfield site in a major city. As part of constructing the house, the house builder installs a pipe from the house to the water main in front of the house. The house builder transfers the pipe to the water company that the latter must use to provide an on going supply of water to the house. The house receives all of the output from that pipe. The house owner has the ability to dictate how much water flows through the pipe, and can restrict the water company from using the pipe for any purpose other than supplying the house. Furthermore, no other user can use that pipe. Should the water company recognize the pipe as an asset? b. The house is built on a greenfield site some distance from the nearest house. A pipe is built that connects the house to the nearest water main (some distance away in a local town) and is transferred to the water company. The house is in an area which is being rapidly developed, and future houses will also be connected to the water pipe. Should the water company recognize the pipe as an asset? Instituut van de Bedrijfsrevisoren 14

15 TRANSFER OF ASSETS IN AN OUTSOURCING AGREEMENT a. An entity enters into an agreement with a customer involving the outsourcing of the customer s information technology (IT) functions. As part of the agreement, the customer transfers ownership of its existing IT equipment to the entity. The entity is responsible for its maintenance and replacement. The entity must use the equipment to provide the service required by the outsourcing agreement. The useful life of the equipment is estimated to be 3 years. The outsourcing agreement requires service to be provided for 10 years for a fixed price lower than the entity would have charged if the IT equipment had not been transferred. How should the entity account for the IT equipment received? b. Refer to case 3.A but assume that after the first three years, the price the entity charges under the outsourcing agreement increases to reflect the fact that it will then be replacing the equipment the customer transferred. How should the entity account for the IT equipment received? Instituut van de Bedrijfsrevisoren 15

16 COMBINING AND SEGMENTING CONSTRUCTION CONTRACTS 1. Olegna Ltd has five construction contracts in progress at the end of 200X, as set out in the table below Total Total contract revenue ,880 Total contract costs ,670 Expected profit (loss) (50) (30) 210 Costs incurred to December 200X ,001 Stage of completion at December 200X 40% 87% 100% 10% 20% 60% Assume that the outcome of each contract can be estimated reliably (Deloitte, igaap 2005, pg 1594). How would the accounting for these contracts differ if they were a. combined and treated as one contract, and b. treated as separate contracts, and 2. Determine for the following arrangements whether the construction should be accounted for as separate contracts or as a combined contract (Deloitte, igaap 2005, pg ) a. A contractor submits two separate bids for the construction of a 10 mile section of motorway and a bridge included in the 10 mile stretch. The government has structured the tender process such that the contract for the motorway construction may be awarded separately from the contract for the bridge. The contractor wins both bids, and a single contract covering both the motorway and the bridge is signed with the government. b. A contractor submits one bid for the construction of a 10 mile section of motorway and a bridge which is at one end of the 10 mile stretch. The bridge is in a different jurisdiction from the motorway but only one bid is submitted because the two authorities have agreed to work together on the construction. The contractor is awarded the work. When the contracts are drawn up, there are separate contracts for the motorway and the bridge since the counterparty (the relevant local authority) differs in each case. c. A contractor is nearing completion of a 10 mile stretch of motorway under a contract with the government. Under the contract, the contractor is paid CU10 million per mile. A supplementary contract is signed between the government and the contractor to cover 13 miles of motorway at the same rate of CU 10 million per mile Instituut van de Bedrijfsrevisoren 16

17 IFRIC 15 AGREEMENTS FOR THE CONSTRUCTION OF REAL ESTATE 1. Construction company Olegna NV buys land for the construction of an office building. Its purpose is to sell the building. Therefore its architect designs the building and submits the plans to the authorities in order to obtain a building permission. At the same time Olegna markets the building still to be constructed to potential lessees and signs conditional lease agreements. The building is also marketed to potential buyers and Olegna signs with one of them a conditional agreement for the sale of land and the construction of the office block. The buyer, entity Enile cannot put the land or the incomplete office block back to the entity. Olegna receives the building permission and all agreements become unconditional. Olegna is given access to the land in order to undertake the construction and then constructs the office block. a. How should Olegna account for the sale of this office building? b. Would your answer change if the construction of the office block started before the entity signed the agreement with the buyer? 2. Olegna is developing residential real estate and starts marketing individual units (apartments) while construction is still in progress. Buyers enter into a binding sale agreement that gives them the right to acquire a specified unit when it is ready for occupation. They pay a deposit that is refundable only if Olegna fails to deliver the completed unit in accordance with the contracted terms. Buyers are also required to make progress payments between the time of the initial agreement and contractual completion. The balance of the purchase price is paid only on contractual completion, when buyers obtain possession of their unit. Buyers are able to specify only minor variations to the basic design but they cannot specify or alter major structural elements of the design of their unit. In the jurisdiction, no rights to the underlying real estate asset transfer to the buyer other than through the agreement. Consequently, the construction takes place regardless of whether sale agreements exist. How should Olegna account for the sale of this office building? Instituut van de Bedrijfsrevisoren 17

18 GROUP DISCUSSION SCOPE OF IAS 11 OR IAS A computer games software house grants two different licenses to arcade games machine manufacturers to use the software for a certain game. The annual license, which has a fee of 100,000 CU, allows the software to be used for one year and can be renewed annually. The perpetual license, which has a fee of 400,000 CU, allows the software to be used indefinitely with the licensee entitled to upgrades free of charge, although the software house is under no obligation to upgrade the software and does not expect to incur significant costs in performing any upgrades. Are the annual license and the perpetual license in the scope of IAS 18 or in the scope of IAS 11? 2. An entity is developing a computer system for a customer. It has sold the hardware to the customer and this has been installed on site. The entity is still developing the related software. The hardware can only be used with related software. The customer has the right to return the hardware if the software does not work. The entity does not anticipate any problem with the software development, which is expects to take about 12 months (Pwc Manual of Accounting (2007), pg. 9038). Is this contract in the scope of IAS 18 or in the scope of IAS 11? Instituut van de Bedrijfsrevisoren 18